Note 10. Income Taxes

A roll-forward of unrecognized tax benefits is as follows:


(in millions)	2017			2016			2015
Opening balance at January 1	$	2.2		$	3.6		$	5.7
Reductions for tax positions of prior periods		0.0			(0.6	)		0.0
Additions for tax positions of prior periods		0.5			0.0			0.3
Additions for current year tax positions		0.0			0.0			1.2
Reductions due to lapsed statute of limitations		(0.5	)		(0.8	)		(3.6	)

Closing balance at 31 December	$	2.2		$	2.2		$	3.6

We recognize accrued interest and penalties associated with unrecognized tax benefits as part of income taxes in our consolidated statements of income. Related to the unrecognized tax benefits noted above, we accrued net interest and penalties of $0.2 million during 2017, a net reduction in interest and penalties of $0.2 million in 2016 and a net reduction in interest and penalties of $0.2 million in 2015. Total accrued interest and penalties at December 31, 2017 on all remaining unrecognized tax benefits amounted to $0.3 million (December 31, 2016 - $0.1 million).

All of the $2.5 million of unrecognized tax benefits, and interest and penalties, would impact our effective tax rate if recognized.

The Company or one of its subsidiaries files income tax returns with the U.S. federal government, and various state and foreign jurisdictions. As previously disclosed, one of the Company’s U.S. subsidiaries was subject to a state tax examination in respect of 2012 through to 2014 inclusive. The examination was completed in the fourth quarter of 2017 at no additional cost to the Company.

The Company and its U.S. subsidiaries are currently subject to a federal income tax examination in respect of 2015. The Company currently anticipates that adjustments, if any, arising out of this tax audit would not result in a material change to the Company’s financial position as at December 31, 2017.

As previously disclosed, tax audits have been opened by the Italian tax authorities in respect of Innospec Performance Chemicals Italia Srl, acquired as part of the Huntsman business in respect of the period 2011 to 2013 inclusive. As a consequence of information received in the fourth quarter of 2017, the Company believes that additional tax of approximately $0.5 million, together with associated interest of $0.2 million, may arise as a result of the 2011 audit. There is insufficient evidence to conclude on the position in relation to 2012 or 2013 at the current time. As any additional tax arising as a consequence of the tax audit would be reimbursed by the previous owner under the terms of the sale and purchase agreement, the Company has recorded an unrecognized tax benefit of $0.7 million in the quarter, together with an indemnification asset of the same amount to reflect the fact that the final liability would be reimbursed by the previous owner.

The Company and its U.S. subsidiaries remain open to examination by the IRS for years 2014 onwards. The Company’s subsidiaries in foreign tax jurisdictions are open to examination including France (2014 onwards), Germany (2015 onwards), Switzerland (2015 onwards) and the United Kingdom (2016 onwards).

The sources of income before income taxes were as follows:


(in millions)	2017		2016		2015
Domestic	$	3.1	$	16.8	$	52.7
Foreign		125.0		86.3		99.6

	$	128.1	$	103.1	$	152.3

The components of income tax expense are summarized as follows:


(in millions)	2017			2016			2015
Current:
Federal	$	51.2		$	4.4		$	5.2
State and local		0.9			1.1			1.3
Foreign		21.0			15.3			14.3

		73.1			20.8			20.8

Deferred:
Federal		(8.1	)		(0.7	)		12.8
State and local		0.7			(0.3	)		0.5
Foreign		0.6			2.0			(1.3	)

		(6.8	)		1.0			12.0

	$	66.3		$	21.8		$	32.8

Cash payments for income taxes were $24.2 million, $23.1 million and $22.5 million during 2017, 2016 and 2015, respectively.

The effective tax rate varies from the U.S. federal statutory rate because of the factors indicated below:


(in percent)	2017			2016			2015
Statutory rate		35.0	%		35.0	%		35.0	%
Foreign income inclusions		2.1			1.0			1.8
Foreign tax rate differential		(13.7	)		(16.6	)		(9.6	)
Tax charge/(credit) from previous years		1.1			(0.7	)		(0.5	)
Net credit from unrecognized tax benefits		(0.4	)		(1.6	)		(1.5	)
Foreign currency transactions		(0.9	)		2.4			(1.9	)
United Kingdom income tax rate reduction		0.0			(0.6	)		(0.7	)
Effect of U.S. tax law change		31.7			0.0			0.0
Other items and adjustments, net		(3.1	)		2.2			(1.1	)

		51.8	%		21.1	%		21.5	%

The most significant factor impacting our effective tax rate is the recognized implications of the Tax Reform Act. U.S. GAAP requires that the impact of tax legislation is recognized in the period in which the law was enacted. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Reform Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Reform Act enactment date for companies to complete their accounting under ASC 740, Income Taxes. Until accounting is complete, companies may record provisional estimates.

As a result of the Tax Reform Act, we accrued a provisional estimate of the mandatory transition tax on our accumulated earnings as of December 31, 2017, resulting in an increase to income tax expense of $47.7 million. In addition, our U.S. deferred tax assets and liabilities were re-measured using a tax rate reduced from 35% to 21% at the same date, which resulted in $7.1 million of deferred income tax benefit.

On account of the complexity of the new Global Intangible Low-Taxed Income (“GILTI”) tax rules, the company continues to evaluate this provision of the Tax Reform Act and the application of ASC 740, Income Taxes. Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current period expense when incurred (the “period cost method”) or factoring such amounts into the Company’s recognition and measurement of its deferred taxes (the “deferred method”). The Company has not yet made any adjustments related to potential GILTI tax in its financial statements and has not yet made an accounting policy decision in respect of GILTI.

We consider the accounting of the transition tax, GILTI provisions and other items to be incomplete due to the forthcoming guidance and our ongoing analysis of final data and tax positions which may impact these calculations.

We expect to complete our analysis within the measurement period in accordance with SAB 118.

The mix of taxable profits generated in the different geographical jurisdictions in which the Group operates continues to have a significant positive impact on the effective rate.

Foreign income inclusions arise each year from certain types of income earned overseas being taxable under the U.S. tax regulations. These types of income include Subpart F income, principally from foreign based company sales in the United Kingdom, including the associated Section 78 tax gross up, and also from the income earned by certain overseas subsidiaries taxable under the U.S. tax regime. Foreign income inclusions have a negative impact on the effective tax rate.

Foreign tax credits can fully or partially offset these incremental U.S. taxes from foreign income inclusions. The utilization of foreign tax credits varies year on year as this is dependent on a number of variable factors which are difficult to predict and may in certain years prevent any offset of foreign tax credits. The effective rate is favorably impacted by the generation of foreign tax credits against foreign income inclusions in 2017.

Other items do not have a material impact on the effective tax rate.

Details of deferred tax assets and liabilities are analyzed as follows:


(in millions)	2017			2016
Deferred tax assets:
Stock compensation	$	4.3		$	5.5
Net operating loss carry forwards		15.9			18.2
Other intangible assets		4.8			3.7
Accretion expense		3.3			5.1
Other		4.5			9.5

Subtotal		32.8			42.0
Less valuation allowance		0.0			0.0

Total net deferred tax assets	$	32.8		$	42.0


Deferred tax liabilities:
Property, plant and equipment	$	(16.7	)	$	(13.0	)
Intangible assets including goodwill		(27.0	)		(38.0	)
Pension asset		(18.3	)		(8.2	)
Investment impairment recapture		(3.5	)		0.0
Customer relationships		(5.8	)		0.0
Other		0.0			(0.2	)

Total deferred tax liabilities	$	(71.3	)	$	(59.4	)

Net deferred tax liability	$	(38.5	)	$	(17.4	)

Deferred tax assets	$	6.5		$	14.9
Deferred tax liabilities		(45.0	)		(32.3	)

	$	(38.5	)	$	(17.4	)

The Tax Reform Act reduces the U.S. statutory corporate tax rate from 35% to 21%, effective January 1, 2018, which resulted in the re-measurement of our U.S. deferred tax positions as of December 31, 2017. Consequently, we have recorded a decrease to our net deferred tax liability of $7.1 million, with a corresponding net adjustment to deferred tax benefit of $7.1 million for the year ended December 31, 2017.

The Company evaluates deferred tax assets to determine whether it is more likely than not that they will be realized. Deferred tax assets are reviewed each period on a tax jurisdiction by tax jurisdiction basis to analyze whether there is sufficient positive or negative evidence to support realizability. As a result of the Company’s assessment of its deferred tax assets at December 31, 2017, the Company considers it more likely than not that it will recover the full benefit of its deferred tax assets and no valuation allowance is required.

Should it be determined in the future that it is no longer more likely than not that these assets will be realized, a valuation allowance would be required, and the Company’s operating results would be adversely affected during the period in which such a determination would be made.

Gross net operating loss carry forwards of $75.2 million result in a deferred tax asset of $15.9 million. The net operating loss carry forwards arose in the U.S. and in five of the Company’s foreign subsidiaries. Net operating loss carry forwards of $27.1 million arose from state and federal tax losses in prior and current periods in certain of the Company’s U.S. subsidiaries. It is expected that sufficient taxable profits will be generated in the U.S. against which the federal net operating loss carry forwards of $16.6 million can be relieved prior to their expiration in the period 2035 to 2037, and the state net operating loss carry forwards of $10.5 million can be relieved before their expiration in the period 2022 to 2037. The net operating loss carry forwards in five of the Company’s foreign subsidiaries totaling $48.1 million arose in prior and current periods and it is expected that sufficient taxable profits will be generated against which these net operating loss carry forwards can be relieved. These losses can be carried forward indefinitely without expiration.

The Company is in a position to control whether or not to repatriate foreign earnings and we currently do not expect to make a repatriation in the foreseeable future. No additional income taxes have been provided for on any remaining undistributed foreign earnings not subject to the transition tax, or any additional outside basis difference inherent in these entities, as the earnings continue to be indefinitely reinvested in foreign operations. Determining the amount of unrecognized deferred tax liability related to any remaining undistributed foreign earnings not subject to the transition tax and additional outside basis difference in these entities (i.e. basis difference in excess of that subject to the one-time transition tax) is not practicable at this time.